Why is bottom and top picking a dangerous opportunity? For the sake of example, let’s imagine a typical top picking market scenario where various “top indicators” are giving sells, such as Investors Intelligence at over 55% Bulls, (which historically has been a very good indicator of future weakness) breadth measures over extended and above levels that had typically marked tops in the past, and insiders selling fairly heavily for a month and currently selling even more. Everything points to a top, right? Now, open up your calendar and look back at May 8^th of this year, back when the S&P 500 was at 925. That’s exactly what was happening. Of course, only five weeks later the S&P was trading at prices almost 10% higher. Unfortunately, this is a fairly common occurrence. Similarly, in June of 2002, the levels of bearishness shown in the AAII survey were very consistent with market lows. Of course, the market didn’t bottom until July, and those lows were tested again in October, and then again in March.

One of the reasons that tops and bottoms are so hard to pick is because of market momentum. Long before a top is made, people are simply used to buying every single dip. Similarly, before a bottom is made, folks are well-trained to sell every rally. Thus, every time the market starts to top (or bottom) it is met with more renewed buying (or selling).

Typically, when a top is forming, the market chops back and forth, often causing positions to be stopped out. If a top-picker sets his stops wide, then he has to spend an inordinate amount of time being exhausted from his positions going into the red several times before making any appreciable profit.

A slightly different situation occurs when attempting to pick bottoms. Bottoms tend to be very volatile affairs that are notoriously scary. One can pick the bottom within a day, but get still manage to get stopped out with even a wide stop. If a bottom picker doesn’t use a stop, he then may have to watch the market trade heavily against him, (shredding his nerves in the process) even though the market might soon thereafter move up and make his positions profitable. Often this type of topping or bottoming action can cause such frustration that once the position does get profitable, the trader covers too quickly, missing the much larger profits that will come once the trend has turned in earnest.

There are some of us who are actually pretty decent at picking tops and bottoms, but even then, such can be a mistake. (Just because you may be good at something doesn’t mean it should be done. Example: I’ve got a pretty good record, with over 95% accuracy, of pointing out to my wife just how many times she’s lost her keys in the last 6 months while she’s hurriedly looking for them.)

Overall, it is easier, both technically and emotionally, to trade with the appropriate trend. If a market looks toppy, it’s best to wait until there is objective evidence that the trend has turned before taking a short. If the market looks to be near a low, it’s best to wait for clear evidence of a reversal. There are numerous methods of making an objective determination of trend. Good old fashioned chart work is dandy, as are moving averages. When day trading, I like to use the daily and hourly MACD as my trend determinants, but there are many other tools, some of them no doubt better.

 The important thing to remember is that the costs of picking tops and bottoms are often too high and the rewards are just too small to justify fighting the trend. You’ll save energy and money by simply waiting for a clear turn before taking a position. I’ve learned that the opportunity to reach for that perfect zen-like trade, specifically from top and bottom picking, is an opportunity best to be passed on. I lose less hair that way.